Financially-minded people sometimes throw around a figure called “net worth.”
Perhaps you've heard of celebrities (like Jay-Z 0r the Kardashians), politicians (like Donald Trump or Mitt Romney), or business owners (like Bill Gates or Mark Zuckerberg) talk about their net worth.
So what is net worth anyway?
Great question. In this article, I'm going to explain exactly what net worth is and how to calculate your net worth (and, why you'd want to do so in the first place).
But first, a quick disclaimer about net worth . . . .
You, my friend, are not valuable because of your net worth. You are intrinsically valuable.
You are a human being who can contribute much to this world, and that's just one reason you're much more valuable than your net worth. So if you find that your net worth is a negative number (yep, it happens), don't be discouraged.
Alright, are you ready to learn about net worth? Let's do this.
What is Net Worth?
Net worth is a figure that is calculated by subtracting the sum of your liabilities from the sum of your assets. In other words, it's would be left over if you were to pay off all of your debts with what you own outright.
Now, you might be asking which assets and which liabilities to include in this calculation. That's simple: everything. This includes everything from your mortgage (a liability) to the pen in your desk drawer (an asset). Many times, people and institutions don't put a value on the smaller items individually, but they simply provide a rough estimate of their assets of lesser value.
Examples of Net Worth Calculations
Perhaps one of the best ways to understand net worth is to look at a few fictitious examples. Here are a few for your consideration.
The Smith Family
The Smith family is pretty poor, and doesn't have much in the bank. In fact, they only have $1,250 in their checking account. They have $1,000 in a 401(k), a mortgage on which they owe $160,000, and a decent house that's worth $140,000 (it fell in value over time). They also have two cars. Thankfully, one is paid off (it's worth $3,400) but the other they still owe $10,100 – its value is $12,200. Finally, they have a few assets (furniture, trinkets, and the like) that are valued at around $5,000.
Let's go ahead and calculate their net worth using the figures above, shall we? One of the best ways to do this is to make a list of their assets and their liabilities.
The Smith family has the following assets:
- $1,250 – Checking Account
- $1,000 – 401(k)
- $140,000 – House
- $3,400 – Car 1
- $12,200 – Car 2
- $5,000 – Furnishings and Trinkets
The above assets total $162,850. Wow! That's looks amazing, right? Not so fast . . . .
The Smith family has the following liabilities:
- $160,000 – Mortgage
- $10,100 – Car 2
The above liabilities total $170,100. Not so good.
Remember our formula for net worth? Assets – Liabilities = Net Worth. Let's run that calculation . . . .
$162,850 (Assets) – $170,100 (Liabilities) = -$7,250 (Net Worth).
This means that the net worth of the Smith family is a negative number: -$7,250. Now, that's not actually a horrible net worth. Things could be worse! But there's certainly a lot of room for improvement.
The Jones Family
Let's take a look at one more example.
The Jones family is doing pretty well. They have a checking account worth $6,500 and an emergency fund valued at $35,100. Interestingly, they rent a small apartment, so housing doesn't come into the equation for them. Now, they do have one small student loan on which they owe $2,000. They also have quite a few furnishings and trinkets valued at $15,300. Additionally, they have two Roth IRAs, one valued at $10,400 and the other valued at $3,650. Both of their cars are paid off with one valued at $10,500 and the other valued at $16,700.
Let's calculate their net worth.
The Jones family has the following assets:
- $6,500 – Checking Account
- $35,100 – Emergency Fund
- $15,300 – Furnishings and Trinkets
- $10,400 – Roth IRA 1
- $3,650 – Roth IRA 2
- $10,500 – Car 1
- $16,700 – Car 2
The above assets total $98,150. Whoa. Wait a minute. Their assets total less than the total of the Smith family's assets! But remember, assets don't tell the whole story . . . .
The Jones family has the following liabilities:
- $2,000 – Student Loan
Wow. Their liabilities total – you guessed it – only $2,000.
Let's use the formula again and take a look at their net worth.
$98,150 (Assets) – $2,000 (Liabilities) = $96,150 (Net Worth).
This means that the Jones family has a positive net worth. Fantastic!
Comparing the Families Net Worth
By comparing these two examples, we learn that looks can deceive. If, for example, someone were to compare the homes of both families, they might assume that the Smiths are wealthier than the Jones family. After all, the Smiths live in a house and the Jones family lives in an apartment. But the truth of the matter is that the Jones family has a higher net worth than the Smith family.
Still, if someone were to compare their vehicles, they might conclude that the Jones family is better off. While this is true, comparing the vehicles of both families does not necessarily indicate the net worth of each family. For that, everything must be taken into account.
Why Calculate Net Worth?
As you can see from the examples of the families above, somebody's net worth is something that is hidden from the view of the public unless, of course, that someone chooses to reveal their net worth. Even still, what's the point in revealing one's net worth to others? There really isn't a good reason, unless you're trying to prove something.
However, there is one good reason to calculate your net worth. Have you guessed it?
It's worthwhile calculating your net worth because you can compare your current net worth to your previous net worth. Okay, so maybe you can't go back in time and calculate your net worth (although you might be able to find a paper trail). Big deal. Start now!
By tracking your net worth over time, you can get a feel for your financial progress (or lack thereof). It might encourage you to get another job, pay off some debt, or put a budget together so you can save some more money!
Net worth is a powerful figure because it takes into account both your assets and your liabilities.
In other words, it forces you to not only consider one factor in the equation, but rather the whole equation. Instead of looking only to your assets (which may look and feel appealing) or only to your liabilities (which may seem overwhelmingly burdensome), calculating your net worth lets you take a look at the balance between these two figures – a balance that can be tracked over time as a reliable measure of financial health.
How to Calculate Your Net Worth Over Time
Alright. You know it's a good idea to calculate your net worth. How should you get started?
If you have spreadsheet software on your computer, you can make a really simple spreadsheet to keep track of your net worth over time. Create two columns: one column for your assets and one column for your liabilities. List out your figures respectively in each column, and if you're fancy, program it to total the columns and subtract the liabilities total from the assets total. This will give you your net worth.
But you can do more than this – and perhaps you should. Recalculate your net worth every single month. Over time, you'll be able to see your net worth go up or down in value. This is a fantastic visual aid in understanding how you're doing with your finances.
Once you've calculated your net worth and have a few months of data, don't just stare at the numbers – do something! If your net worth is increasing, ask yourself why and keep doing those things. If your net worth is decreasing, ask yourself why and change something!
If you're in that second camp, or your net worth simply looks grim, here are a few articles you need to read:
- How to Make a Budget That Actually Works!
- 70 Super Easy and Practical Ways to Save Money
- 9 Strategies to Build Wealth Fast (That Your Financial Advisor Won't Tell You)
Thanks for learning about net worth. If you haven't calculated your net worth yet, get to it! What you find just might be the fuel you need to make positive changes in your life.